summary of Zimbabwean Banking Sector (Part One)

Law Of Diminishing Returns Business Definition - summary of Zimbabwean Banking Sector (Part One)

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Entrepreneurs build their business within the context of an environment which they sometimes may not be able to control. The robustness of an entrepreneurial venture is tried and tested by the vicissitudes of the environment. Within the environment are military that may serve as great opportunities or menacing threats to the survival of the entrepreneurial venture. Entrepreneurs need to understand the environment within which they operate so as to exploit emerging opportunities and mitigate against possible threats.

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Law Of Diminishing Returns Business Definition

This narrative serves to generate an understanding of the military at play and their effect on banking entrepreneurs in Zimbabwe. A brief historical overview of banking in Zimbabwe is carried out. The impact of the regulatory and economic environment on the sector is assessed. An analysis of the structure of the banking sector facilitates an appreciation of the underlying military in the industry.
Historical Background

At independence (1980) Zimbabwe had a sophisticated banking and financial market, with market banks mostly foreign owned. The country had a central bank inherited from the Central Bank of Rhodesia and Nyasaland at the winding up of the Federation.

For the first few years of independence, the government of Zimbabwe did not interfere with the banking industry. There was neither nationalisation of foreign banks nor restrictive legislative interference on which sectors to fund or the interest rates to charge, despite the socialistic national ideology. However, the government purchased some shareholding in two banks. It acquired Nedbank's 62% of Rhobank at a fair price when the bank withdrew from the country. The decision may have been motivated by the desire to stabilise the banking system. The bank was re-branded as Zimbank. The state did not interfere much in the operations of the bank. The State in 1981 also partnered with Bank of credit and manufactures International (Bcci) as a 49% shareholder in a new market bank, Bank of credit and manufactures Zimbabwe (Bccz). This was taken over and converted to market Bank of Zimbabwe (Cbz) when Bcci collapsed in 1991 over allegations of unethical business practices.

This should not be viewed as nationalisation but in line with state policy to preclude business closures. The shareholdings in both Zimbank and Cbz were later diluted to below 25% each.
In the first decade, no indigenous bank was licensed and there is no evidence that the government had any financial reform plan. Harvey (n.d., page 6) cites the following as evidence of lack of a coherent financial reform plan in those years:

- In 1981 the government stated that it would encourage rural banking services, but the plan was not implemented.
- In 1982 and 1983 a Money and Finance Commission was proposed but never constituted.
- By 1986 there was no mention of any financial reform program in the Five Year National development Plan.

Harvey argues that the reticence of government to intervene in the financial sector could be explained by the fact that it did not want to jeopardise the interests of the white population, of which banking was an integral part. The country was vulnerable to this sector of the habitancy as it controlled agriculture and manufacturing, which were the mainstay of the economy. The State adopted a conservative coming to indigenisation as it had learnt a chapter from other African countries, whose economies nearly collapsed due to forceful eviction of the white community without first developing a mechanism of skills exchange and capacity construction into the black community. The economic cost of inappropriate intervention was deemed to be too high. an additional one plausible presuppose for the non- intervention policy was that the State, at independence, inherited a extremely controlled economic policy, with tight exchange operate mechanisms, from its predecessor. Since operate of foreign currency affected operate of credit, the government by default, had a strong operate of the sector for both economic and political purposes; hence it did not need to interfere.

Financial Reforms

However, after 1987 the government, at the behest of multilateral lenders, embarked on an Economic and Structural Adjustment Programme (Esap). As part of this programme the withhold Bank of Zimbabwe (Rbz) started advocating financial reforms straight through liberalisation and deregulation. It contended that the oligopoly in banking and lack of competition, deprived the sector of selection and capability in service, innovation and efficiency. Consequently, as early as 1994 the Rbz yearly narrative indicates the desire for greater competition and efficiency in the banking sector, leading to banking reforms and new legislation that would:

- allow for the guide of prudential supervision of banks along international best practice
- allow for both off-and on-site bank inspections to growth Rbz's Banking supervision function and
- improve competition, innovation and improve assistance to the communal from banks.

Subsequently the Registrar of Banks in the Ministry of Finance, in liaison with the Rbz, started issuing licences to new players as the financial sector opened up. From the mid-1990s up to December 2003, there was a flurry of entrepreneurial action in the financial sector as indigenous owned banks were set up. The graph below depicts the trend in the numbers of financial institutions by category, operating since 1994. The trend shows an initial growth in merchant banks and discount houses, followed by decline. The growth in market banks was initially slow, gathering momentum colse to 1999. The decline in merchant banks and discount houses was due to their conversion, mostly into market banks.

Source: Rbz Reports

Different entrepreneurs used discrete methods to drill the financial services sector. Some started advisory services and then upgraded into merchant banks, while others started stockbroking firms, which were elevated into discount houses.

From the beginning of the liberalisation of the financial services up to about 1997 there was a noted absence of locally owned market banks. Some of the reasons for this were:

- Conservative licensing policy by the Registrar of Financial Institutions since it was risky to licence indigenous owned market banks without an enabling legislature and banking supervision experience.
- Banking entrepreneurs opted for non-banking financial institutions as these were less high-priced in terms of both initial capital requirements and working capital. For example a merchant bank would need less staff, would not need banking halls, and would have no need to deal in high-priced small sell deposits, which would cut overheads and cut the time to register profits. There was thus a rapid growth in non-banking financial institutions at this time, e.g. By 1995 five of the ten merchant banks had commenced within the previous two years. This became an entry route of selection into market banking for some, e.g. Kingdom Bank, Nmb Bank and Trust Bank.

It was predicted that some foreign banks would also enter the shop after the financial reforms but this did not occur, probably due to the restriction of having a minimum 30% local shareholding. The stringent foreign currency controls could also have played a part, as well as the cautious coming adopted by the licensing authorities. Existing foreign banks were not required to shed part of their shareholding although Barclay's Bank did, straight through listing on the local stock exchange.

Harvey argues that financial liberalisation assumes that removing direction on lending presupposes that banks would automatically be able to lend on market grounds. But he contends that banks may not have this capacity as they are affected by the borrowers' inability to assistance loans due to foreign exchange or price operate restrictions. Similarly, having distinct real interest rates would regularly growth bank deposits and growth financial intermediation but this logic falsely assumes that banks will all the time lend more efficiently. He supplementary argues that licensing new banks does not imply increased competition as it assumes that the new banks will be able to attract competent supervision and that legislation and bank supervision will be enough to preclude fraud and thus preclude bank collapse and the resultant financial crisis. Sadly his concerns do not seem to have been addressed within the Zimbabwean financial sector reform, to the detriment of the national economy.

The Operating Environment

Any entrepreneurial action is constrained or aided by its operating environment. This section analyses the prevailing environment in Zimbabwe that could have an effect on the banking sector.

Politico-legislative

The political environment in the 1990s was carport but turned volatile after 1998, in general due to the following factors:

- an unbudgeted pay out to war veterans after they mounted an attack on the State in November 1997. This exerted a heavy strain on the economy, resulting in a run on the dollar. Resultantly the Zimbabwean dollar depreciated by 75% as the shop foresaw the consequences of the government's decision. That day has been recognised as the beginning of severe decline of the country's economy and has been dubbed "Black Friday". This depreciation became a catalyst for supplementary inflation. It was followed a month later by violent food riots.
- a poorly planned Agrarian Land Reform launched in 1998, where white market farmers were ostensibly evicted and substituted by blacks without due regard to land possession or compensation systems. This resulted in a important discount in the productivity of the country, which is mostly dependent on agriculture. The way the land redistribution was handled angered the international community, that alleges it is racially and politically motivated. International donors withdrew withhold for the programme.
- an ill- advised military incursion, named operation Sovereign Legitimacy, to defend the Democratic Republic of Congo in 1998, saw the country incur heavy costs with no apparent advantage to itself and
- elections which the international community alleged were rigged in 2000,2003 and 2008.

These factors led to international isolation, significantly reducing foreign currency and foreign direct venture flow into the country. Investor trust was severely eroded. Agriculture and tourism, which traditionally, are huge foreign currency earners crumbled.

For the first post independence decade the Banking Act (1965) was the main legislative framework. Since this was enacted when most market banks where foreign owned, there were no directions on prudential lending, insider loans, proportion of shareholder funds that could be lent to one borrower, definition of risk assets, and no provision for bank inspection.

The Banking Act (24:01), which came into effect in September 1999, was the culmination of the Rbz's desire to liberalise and deregulate the financial services. This Act regulates market banks, merchant banks, and discount houses. Entry barriers were removed leading to increased competition. The deregulation also allowed banks some latitude to operate in non-core services. It appears that this latitude was not well delimited and hence presented opportunities for risk taking entrepreneurs. The Rbz advocated this deregulation as a way to de-segment the financial sector as well as improve efficiencies. (Rbz, 2000:4.) These two factors presented opportunities to enterprising indigenous bankers to organize their own businesses in the industry. The Act was supplementary revised and reissued as chapter 24:20 in August 2000. The increased competition resulted in the introduction of new products and services e.g. E-banking and in-store banking. This entrepreneurial action resulted in the "deepening and sophistication of the financial sector" (Rbz, 2000:5).

As part of the financial reforms drive, the withhold Bank Act (22:15) was enacted in September 1999.

Its main purpose was to develop the supervisory role of the Bank through:
- setting prudential standards within which banks operate
- conducting both on and off-site watch of banks
- enforcing sanctions and where important placement under curatorship and
- investigating banking institutions wherever necessary.

This Act still had deficiencies as Dr Tsumba, the then Rbz governor, argued that there was need for the Rbz to be responsible for both licensing and supervision as "the greatest sanction available to a banking supervisor is the knowledge by the banking sector that the license issued will be cancelled for flagrant violation of operating rules". However the government seemed to have resisted this until January 2004. It can be argued that this insufficiency could have given some bankers the impression that nothing would happen to their licences. Dr Tsumba, in observing the role of the Rbz in retention bank management, directors and shareholders responsible for banks viability, stated that it was neither the role nor intention of the Rbz to "micromanage banks and direct their day to day operations. "

It appears though as if the view of his successor differed significantly from this orthodox view, hence the evidence of micromanaging that has been observed in the sector since December 2003.
In November 2001 the Troubled and Insolvent Banks Policy, which had been drafted over the previous few years, became operational. One of its intended goals was that, "the policy enhances regulatory transparency, accountability and ensures that regulatory responses will be applied in a fair and consistent manner" The prevailing view on the shop is that this policy when it was implemented post 2003 is right on deficient as measured against these ideals. It is contestable how transparent the inclusion and exclusion of vulnerable banks into Zabg was.

A new governor of the Rbz was appointed in December 2003 when the economy was on a free-fall. He made important changes to the monetary policy, which caused tremors in the banking sector. The Rbz was finally authorised to act as both the licensing and regulatory authority for financial institutions in January 2004. The regulatory environment was reviewed and important amendments were made to the laws governing the financial sector.

The Troubled Financial Institutions Resolution Act, (2004) was enacted. As a effect of the new regulatory environment, a amount of financial institutions were distressed. The Rbz located seven institutions under curatorship while one was finished and an additional one was located under liquidation.

In January 2005 three of the distressed banks were amalgamated on the authority of the Troubled Financial Institutions Act to form a new institution, Zimbabwe Allied Banking Group (Zabg). These banks allegedly failed to repay funds advanced to them by the Rbz. The affected institutions were Trust Bank, Royal Bank and Barbican Bank. The shareholders appealed and won the motion against the seizure of their assets with the consummate Court ruling that Zabg was trading in illegally acquired assets. These bankers appealed to the minister of Finance and lost their appeal. Subsequently in late 2006 they appealed to the Courts as provided by the law. finally as at April 2010 the Rbz finally agreed to return the "stolen assets".

Another part taken by the new governor was to force supervision changes in the financial sector, which resulted in most entrepreneurial bank founders being forced out of their own associates under varying pretexts. Some ultimately fled the country under threat of arrest. Boards of Directors of banks were restructured.

Economic Environment

Economically, the country was carport up to the mid 1990s, but a downturn started colse to 1997-1998, mostly due to political decisions taken at that time, as already discussed. Economic policy was driven by political considerations. Consequently, there was a relinquishment of multi- national donors and the country was isolated. At the same time, a drought hit the country in the season 2001-2002, exacerbating the injurious effect of farm evictions on crop production. This reduced output had an adverse impact on banks that funded agriculture. The interruptions in market farming and the concomitant discount in food output resulted in a precarious food protection position. In the last twelve years the country has been forced to import maize, supplementary straining the tenuous foreign currency resources of the country.

Another impact of the agrarian reform programme was that most farmers who had borrowed money from banks could not assistance the loans yet the government, which took over their businesses, refused to assume accountability for the loans. By concurrently failing to recompense the farmers at once and fairly, it became impractical for the farmers to assistance the loans. Banks were thus exposed to these bad loans.

The net effect was spiralling inflation, business closures resulting in high unemployment, foreign currency shortages as international sources of funds dried up, and food shortages. The foreign currency shortages led to fuel shortages, which in turn reduced market production. Consequently, the Gross Domestic stock (Gdp) has been on the decline since 1997. This negative economic environment meant reduced banking action as market action declined and banking services were driven onto the parallel rather than the formal market.

As depicted in the graph below, inflation spiralled and reached a peak of 630% in January 2003. After a brief reprieve the upward trend prolonged rising to 1729% by February 2007. Thereafter the country entered a period of hyperinflation unheard of in a peace time period. Inflation stresses banks. Some argue that the rate of inflation rose because the devaluation of the currency had not been accompanied by a discount in the budget deficit. Hyperinflation causes interest rates to soar while the value of collateral protection falls, resulting in asset-liability mismatches. It also increases non-performing loans as more habitancy fail to assistance their loans.

Effectively, by 2001 most banks had adopted a conservative lending strategy e.g. With total advances for the banking sector being only 21.7% of total manufactures assets compared to 31.1% in the previous year. Banks resorted to volatile non- interest income. Some began to trade in the parallel foreign currency market, at times colluding with the Rbz.

In the last half of 2003 there was a severe cash shortage. habitancy stopped using banks as intermediaries as they were not sure they would be able to access their cash whenever they needed it. This reduced the deposit base for banks. Due to the short term maturity profile of the deposit base, banks are regularly not able to invest important portions of their funds in longer term assets and thus were extremely liquid up to mid-2003. However in 2003, because of the interrogate by clients to have returns matching inflation, most indigenous banks resorted to speculative investments, which yielded higher returns.

These speculative activities, mostly on non-core banking activities, drove an exponential growth within the financial sector. For example one bank had its asset base grow from Z0 billion (Usd50 million) to Z0 billion (Usd200 million) within one year.

However bankers have argued that what the governor calls speculative non-core business is considered best institution in most advanced banking systems worldwide. They argue that it is not unusual for banks to take equity positions in non-banking institutions they have loaned money to safeguard their investments. Examples were given of banks like Nedbank (Rsa) and J P Morgan (Usa) which operate vast real estate investments in their portfolios. Bankers argue convincingly that these investments are sometimes used to hedge against inflation.

The education by the new governor of the Rbz for banks to unwind their positions overnight, and the immediate relinquishment of an overnight chamber withhold for banks by the Rbz, stimulated a emergency which led to important asset-liability mismatches and a liquidity crunch for most banks. The prices of properties and the Zimbabwe Stock exchange collapsed simultaneously, due to the heavy selling by banks that were trying to cover their positions. The loss of value on the equities shop meant loss of value of the collateral, which most banks held in lieu of the loans they had advanced.

During this period Zimbabwe remained in a debt crunch as most of its foreign debts were whether un-serviced or under-serviced. The effect worsening of the equilibrium of payments (Bop) put pressure on the foreign exchange reserves and the overvalued currency. Total government domestic debt rose from Z.2 billion (1990) to Z.8 trillion (2004). This growth in domestic debt emanates from high budgetary deficits and decline in international funding.

Socio-cultural

Due to the volatile economy after the 1990s, the habitancy became fairly movable with a important amount of professionals emigrating for economic reasons. The Internet and Satellite television made the world truly a global village. Customers demanded the same level of assistance excellence they were exposed to globally. This made assistance capability a differential advantage. There was also a interrogate for banks to invest heavily in technological systems.

The increasing cost of doing business in a hyperinflationary environment led to high unemployment and a concomitant collapse of real income. As the Zimbabwe Independent (2005:B14) so keenly observed, a direct outcome of hyperinflationary environment is, "that currency substitution is rife, implying that the Zimbabwe dollar is relinquishing its function as a store of value, unit of account and medium of exchange" to more carport foreign currencies.

During this period an affluent indigenous segment of community emerged, which was cash rich but avoided patronising banks. The emerging parallel shop for foreign currency and for cash during the cash emergency reinforced this. Effectively, this reduced the customer base for banks while more banks were coming onto the market. There was thus aggressive competition within a dwindling market.

Socio-economic costs connected with hyperinflation include: erosion of purchasing power parity, increased uncertainty in business planning and budgeting, reduced disposable income, speculative activities that divert resources from effective activities, pressure on the domestic exchange rate due to increased import interrogate and poor returns on savings. during this period, to augment revenue there was increased cross border trading as well as commodity broking by habitancy who imported from China, Malaysia and Dubai. This effectively meant that imported substitutes for local products intensified competition, adversely affecting local industries.

As more banks entered the market, which had suffered a major brain drain for economic reasons, it stood to presuppose that many new bankers were thrown into the deep end. For example the founding directors of Eng Asset supervision had less than five years experience in financial services and yet Eng was the fastest growing financial institution by 2003. It has been recommend that its failure in December 2003 was due to juvenile zeal, greed and lack of experience. The collapse of Eng affected some financial institutions that were financially exposed to it, as well as eliciting depositor flight leading to the collapse of some indigenous banks.

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